Is the S&P 500 About to Double-Top Out?

If past is prologue, this formation actually is a good sign

The S&P 500 Index, which closed at 1,419 on April 2, trended lower through the summer before recovering to an intraday peak of 1,426 on Aug. 21. Since then, the index has trended slightly lower. This series of events has fueled concerns that the market might be moving into a “double top” chart formation, which in theory should bode poorly for the near-term outlook.

But if stocks do indeed pause for a breather here, technicals are unlikely to be the cause. A look at the charts for each calendar year dating back to 1962 shows that this setup — a spring peak followed by early summer weakness and a move back to the previous highs by later summer/early fall — is in fact quite common, occurring in 12 of the past 50 years. And on balance, this series of events has been favorable for the market.

The table below shows the years in which the S&P has followed the pattern set forth above, together with the corresponding dates for the spring high and the date at which that high was retaken. The return figures show the S&P’s return from the second date through the final trading day of the year.

The results speak for themselves: The index has traded higher on 11 of 12 occasions, and it has averaged a gain of 4.1% off of the formation we’re seeing right now.

Year

First-Half High

Retest

Subsequent Return

1961

4/17

9/6

4.5%

1963

5/31

8/13

6.0%

1965

5/14

9/22

2.2%

1967

5/8

7/28

2.1%

1972

4/12

8/4

6.9%

1979

4/10

7/31

4.0%

1982

5/12

9/2

16.9%

1993

3/9

8/18

2.3%

1996

5/24

9/13

11.2%

2000

3/24

9/1

-13.2%

2006

5/5

9/25

6.9%

2010

4/22

11/4

3.0%

Among the 12 similar years, the one that looks most like today’s is 2006 — a year that saw stellar returns in the final months of the year.

2012 Year-to-Date

2006 through 9/25

In the one outlier year, 2000, investors had a clue that the market wasn’t going to go the way it had on the previous nine occasions — after failing at its previous high, it continued to slide and subsequently broke below its 200-day moving average. In all of the other years except for 1979, the market remained above its 200-day for the vast majority of the period following the retest.

A break below the 200-day might therefore be a sign that the historical pattern isn’t going to hold in 2012. Currently, the 200-day MA is about 5% below the index level.

2000

There’s a limit to how much this historical information truly reveals. Each year has its own chart formation and unique set of fundamental circumstances, and the markets are more sensitive to policy developments now than at any point in the past. Still, if the market slips a few more points, the pundits are likely to flood the airwaves with pronouncements that a double top is at hand.

If that occurs, consider this historical record before you get scared out of potentially profitable trades.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.